News Analysis

New Strategy From AOL Leaves Many Unconvinced

By SAUL HANSELL

Published: December 5, 2002

For all the talk Tuesday of a new, humbled, content-driven America Online, the core of its strategy remains largely unchanged — that it can justify a premium price by appealing to families that go online mainly to communicate with one another.

And since that strategy led to the company's current stagnation, investors and analysts walked away from AOL Time Warner's four-hour meeting unconvinced that AOL's product plans were strong enough to reignite its growth anytime soon.

Shares of AOL Time Warner, which had been at $16.57 Monday, closed at $13.84 yesterday, down 37 cents.

Even Mary Meeker, the Morgan Stanley analyst who helped persuade the companies to combine three years ago, downgraded AOL Time Warner shares yesterday.

She wrote that management outlined the right plan — improve service, move customers to higher-speed broadband connections and create new revenue opportunities. But the plan, she said, was two years too late, and AOL may be so far behind that it may not catch up.

"We can't recall seeing a business in a dynamic/competitive consumer-oriented technology-related market with so much opportunity and such a powerful customer base and business model cede so much relative ground over a two-plus-year period and recover to sustainable growth," she wrote in a note to clients.

One sign of how far AOL is behind, Ms. Meeker said, was that in the third quarter the service added only a net 129,000 customers. That was fewer than the 269,000 subscribers added by MSN from Microsoft or the 141,000 added by the discount-price United Online , which operates Juno.

The biggest news Tuesday, in fact, may have been what the company did not say. Many analysts had expected it to lower the price of its high-speed broadband service to pick up market share. AOL has generally charged $10 to $15 a month more than generic high-speed services offered by cable and telephone companies. It has a far smaller share of that growing market than of the large but slow-growing market for dial-up or narrowband service.

But Jonathan Miller, the unit's chief executive, repeatedly said that company research indicated that customers were willing to spend $14.95 a month for AOL's service in addition to what they pay for a broadband connection — generally $40 to $50 a month. Cutting the premium, he said, did not increase sales.

AOL has defied common wisdom before. All of its phenomenal success in the late 1990's came despite experts' decrees that its version of the Internet on training wheels would be eclipsed by true Internet services. But those experts generally were those who did not have teenage children whose social life centered on having a dozen simultaneous instant- message conversations. Nor were they so technically baffled that AOL's reputation as the safe and easy way to get online was paramount to them.

Michael E. Gallant, an analyst with CIBC World Markets, argues that AOL still has more appeal in the marketplace than many skeptics will admit — but far less than AOL appears to be counting on.

"AOL pretty much owns the mass consumer who doesn't like change, and is too dumb and lazy to change his e-mail address," he said. "But $15 a month is too high and they will ultimately be forced to introduce lower-priced plans."

Mr. Gallant said AOL would be better off with a price closer to the $9.95 that Microsoft is charging for access to some of the more advanced features of the MSN service.

Lisa A. Hook, the president of AOL's broadband unit, insisted that the company's premium is well accepted by the market. "Historically, we have had a huge price gap," she said. "We were $20 more than the free services. And we are still seen as a premium brand by members."

AOL had hoped to extend its advantage into broadband access by offering customers a simple way to upgrade by bundling its service with a high-speed connection, purchased on a wholesale basis from a cable or telephone company at one price.

But these deals have proved difficult to manage. Broadband installations are complicated, and customers were confused about what parts of the service were actually operated by AOL and what parts by other companies. More important, after years of trying, AOL could not reach deals with most cable companies and many smaller phone companies.

"We were trying to get deals that many of the connectivity providers didn't believe was in their best interests," Ms. Hook said.

AOL's decision to emphasize its $14.95 bring-your-own-access plan is in many ways an admission of defeat. That plan is used by customers who buy broadband connections from another provider but still want to use AOL's e-mail, chat rooms and content. AOL will be promoting that plan to its members. "We wanted a national footprint without negotiating with all 1,300 local phone companies," Ms. Hook said.

At the same time, she said AOL would still prefer to negotiate all-in-one packages with cable and phone companies to make the process of getting high-speed Internet service easier for consumers. It has developed a new approach to these deals that includes the brand of the network provider along with AOL's. That makes things clearer for consumers and less of a threat to the cable and phone companies.

In the first of those deals, with Comcast , AOL will price the bundled service at $55 a month, $6 less than the combined price of Comcast's broadband service and AOL's bring-your-own-access plan.